Hi, my name is Matt Brown. I’m the Founder and CEO of CAIS, and I’m joined by Lee Beck, Managing Partner of Kudu Investments. Lee, thanks so much.

Lee Beck:

Thank you.

Matt Brown:

Quite an exciting couple days here at Milken.

Lee Beck:

Amazing.

Matt Brown:

Learning a lot, and getting exposed to a lot. I know when I come here after being so focused in one area of my day to day work, coming here and hearing all the ideas from so many great participants across the world, and their takes from technology to healthcare to education, it just allows me to kind of take a bit of a holiday and think differently. What are some of the early observations that you’ve seen and takeaways from this great conference?

Lee Beck:

Well, thanks again for the invite.

Matt Brown:

Yeah.

Lee Beck:

Great conference. Seeing the global lead is the [inaudible 00:01:06] that is here is an understatement in my view, and feel fortunate to be here with so many of them. But some of the observations I’ve made, you look at Christine [inaudible 00:01:15], to start off the conference yesterday talking about how productivity matters. It’s the key element that she’s trying to measure growth in the global market.But, she’s … there’s this mysterious gap in terms of inflation. She can’t understand why it’s not there. The question of the Philips curve, is it real? Is it gone? That was an interesting sight, but her viewpoint at 40% of the world’s debt, sovereign debt, is in distressed state, but has a majority of the population. But technology’s weaving into all of these aspects of her conversations and some of the others, and the technology keeping inflation down, which was some of the discussion that took place with Christine, allowing interest rates to stay low, allowing costs of capital and price of goods to stay low. It’s benefiting this concept of how do we broaden out participation across the global markets in terms of population and prosperity? The theme of this conference. If we go from Christine [inaudible 00:02:11] to Justin Bateman, one of my favorite actors-

Matt Brown:

Yeah, of course.

Lee Beck:

Talking about Ozarks. A show that if you haven’t seen on Netflix, you have to.

Matt Brown:

I’ve seen all the … I’m current.

Lee Beck:

I’m not.

Matt Brown:

I wish they’d come out with the next one.

Lee Beck:

I’m not. I need to catch up.

Matt Brown:

Yeah.

Lee Beck:

But I thought it was interesting, his perspective as an actor and a director, and the influence that Netflix is having, again this technology theme. We talked about technology maybe inhibiting inflation from Christine’s perspective, but in Jason talking about how he now can put out a show like Ozarks, and the consumer can consume whenever they like, no pun intended, in whatever medium they have. It has some black spots to it, or some dark spots to it, where he would say, “I don’t know how many people are actually watching the show.” Netflix can’t give him that information, but they can tell him what medium it’s on screen, or what time of the day, at evening, so he can acutely create the best environment for the show to operate in, it’s appealing to the consumer. So the consumer’s getting more demand.

Matt Brown:

I think that’s spot on, and I think that that theme of being able to curate your experience, and the fact that technology is allowing you to curate your experience more and more in everything. One of the big takeaways that I’ve seen, or heard in the last couple days, had the pleasure of speaking with some great technologists, Sean Parker, Eric Schmidt, Mike Milken himself, of course. We had a conversation around the role of predictive technology. The ability and the efficiency that predictive technology can actually bring to the community at large. One thing they were very clear on saying is that no matter where we go with artificial intelligence, big data, predictive technology, the human being, the human element, is still going to be critical in the process. The role may change and shift, maybe it’s more about analyzing the data, but always making sure that we’re not thinking about it as automating ourselves out of a role, automating ourselves out of a function.

Lee Beck:

What’s interesting, especially in your role, now I’ll contrast it to [inaudible 00:04:19] yesterday spoke a little bit about these investments of the Vision Fund, 100 billion dollar fund, 80 portfolios … companies in the portfolio now, they’ve made investments on. But to your point, they talked about how the middle man is being pushed out, and these cost-efficiencies are great for the businesses, where they’re connecting the consumer directly to the products.

Matt Brown:

Right.

Lee Beck:

This democratization’s occurring, and they find that’s going to be an advantage for them at an appropriate level, they’re investing in disruptors. Now when I was listening to that, I thought of your firm, you know, democratizing alternative investments, and how you’re bringing the individual to a much needed aspect of the investment portfolio, alternative investments, private equity, [inaudible 00:05:03] and other. You’re democratizing … you’re actually creating shared prosperity, in terms of the business model you’re creating. I think … I’d love for you to elaborate on how that model that you’re building relates to what [inaudible 00:05:15] is trying to do globally in a very different context. But what Netflix is doing, what Christine’s worried about with inflation and the consumer having control, what do you think about that? How’s it feel where you are?

Matt Brown:

I appreciate that lead in. You know, when we were … Early on, thinking about what business model we wanted to adopt, and what area we wanted to go, some of the stats that we were looking at for the wealth management industry, this is even before we decided to build an alternatives platform, was that wealth management, which is a 20 plus trillion dollar market in America, meaning money managed by a financial advisor, has an average allocation to alternatives below 10%, closer to 5%.

Lee Beck:

From what I understand, you’re actually being kind.

Matt Brown:

And I’m being kind. Then when you actually separate out wirehouse wealth management, the top big firms that control half the market, with independent wealth management, which is the boutique business, the thousands of firms, which coincidentally actually manage the same amount of money, but there’s just thousands of them. The number is closer to 1% in the independent channel.

Lee Beck:

Why do you think that is? Because that’s a … If you look at any institutional allocators, from an OCIO, to some of the largest pensions and endowments, their average exposure to alternative investments is 15%, 20%, 25%. There’s a number-

Matt Brown:

It’s closer to 30% now, 35%-

Lee Beck:

So why is it only-

Matt Brown:

When you include real estate. You know, there’s a lot of reasons for it, and that’s actually the problem that we want to go out and try and solve. Which is, we identified that there’s an underallocation, we know that the clients, the high net worth individuals who are being advised by those financial advisors, needed access to all those tools to be able to properly have a fair shot at managing their portfolio, just like the big institutions. So why aren’t they utilizing the best tools in the tool box? Why are they not looking at private equity, venture, real estate, credit, and [inaudible 00:07:12] strategies? It really zeroed in on four areas, and we’re solving all four right now in order to get the usage of these types of products higher. The first area, believe it or not, it’s just simple access. If you can believe it, knowing where to go, who to call, and seeing maybe a consolidated menu, or being able to afford to buy into these funds, just the access alone is a huge barrier. So at CAIS what we did, is we built a financial technology platform that allows the financial advisor to log in, and begin to just see funds and opportunities that they can actually evaluate, a centralized location. Just by presenting it in a consolidated way, has moved the needle fairly dramatically. You know, you read about big firms like Blackstone in the Wall Street Journal, and you read about other firms, but the financial advisor’s sitting in Texas, or sitting in the Midwest, or in California, wherever. Who do you really call? And how do you get that access? So, we solved the access part, and technology, of course, playing a big role. But if I really had to zero in on what’s going to move the needle here-

Lee Beck:

Yeah, because technology can’t be the only factor. It’s a tool-

Matt Brown:

It’s a tool.

Lee Beck:

It got you here, but what really would matter?

Matt Brown:

But I’ll just talk about the barrier first, and I’ll talk about the solution. If I look at the real barrier of why those allocation rates are so low, right now, financial advisors in the independent wealth channel don’t have the resources for due diligence, or the resources for education. As a fiduciary, if you’re trying to put money to work on behalf of your client, if you’re trying to evaluate investments, and you don’t have the resources to be able to do due diligence on funds, or alternatively, learn about these products or trends, or strategies, it’s very hard to feel comfortable putting money to work. So, with the incorporation of artificial intelligence in our platform and machine learning, we’re actually revolutionizing education in the alternative space. In 2019, we are going to be rolling out the first artificial intelligence learning platform for independent wealth advisors in alternative investments.

Lee Beck:

So, you kind of … you’re the Netflix of the alternative investment space. You’re democratizing, giving consumers choice, bringing it at a reasonable cost point, bringing investments that really never were available to them before, right to a simple menu. What about the process … I’ve always heard though that the process, I have it myself to my own relationships, the process of completing the forms, completing the work, all of the work of … all the impediments or hurdles of … this sounds great, it should be an investment I take on, it’s bringing me a level of prosperity, if you will, that I should have included in my portfolio, it’s going to drive results, but it’s cumbersome. How do you solve those problems?

Matt Brown:

Yeah. You know, it’s often times the first question people ask. They kind of skip over the-

Lee Beck:

It’s a pain point we all remember.

Matt Brown:

Do I want the fund? Do I know how to evaluate it? But, we quickly get to, “Well, even after I do all that work, how do I even buy it? And is that process a barrier in and of itself?”

Lee Beck:

How do I look at its statements? How do I know what’s going on over time?

Matt Brown:

We had to tackle that head on, and in many of the things we did, we pioneered a lot of the plumbing and piping for alternative investments to live seamlessly in an ecosystem. When you go buy a mutual fund, do you worry about how to buy it? Do you worry about the fact that it’s going to show up on your statement?

Lee Beck:

No, not at all.

Matt Brown:

No, of course not. But believe it or not, 30 years ago, or 40 years ago, you would’ve had to. Mutual funds are actually bought with paper documents in the old days, just like where alternative investments are today. We are streamlining that process, we’ve made the entire end-to-end workflow from filling out the subscription form, to executing the order, to connecting the reporting to your centralized location, seamless and electronic. We’ve effectively digitized the process. Now, that’s great, but then what’s the next level? What’s beyond that? Well, we’re not-

Lee Beck:

Give us a little bit more weaving that vision of looking out three to five years, which everyone has been asked here, especially in the role of A CEO. Everyone wants to hear the vision of where this is going. So you’ve done a lot of work here, you’ve democratized, you created that Netflix of alternative investments, in terms of connectivity to clients. What happens from here? That list of vision.

Matt Brown:

So, I always start in the same place when I get asked this question, which is, you know, what’s the end game? Or what’s the future vision? I deeply believe that it’s all about the customer or the client. If you focus on the best for the customer, or best for the end client, and allow your business to drive in that direction, you’ll always end up on the right side. So, what is in the best interest of the end investor, or the fiduciary financial advisor that’s tasked with the responsibility to be the guardian of your capital? Is to be able to have tools that are effective to protect your client’s capital in a down market, and prosper in good markets. So, when I look out three, five, 10 years, yes, we will automate all this archaic workflow, for sure. We will bring better due diligence frameworks for safer investing, absolutely. We will have a smarter consumer through artificial intelligence and learning. But, ultimately, what we’ll have is we will have advisors who are using alternative investments for the right reasons to protect and grow client wealth long-term at a much higher percentage rate than 1%.

Lee Beck:

If there was one thing from the conference that stuck out in your head, related to all that we’ve been speaking about, democratization, prosperity, the change, in terms of investment considerations for clients, the focus on the end investor, the privileges we have in this technology era of innovation. Any of these stick out in your mind from all the other conversations and speakers you’ve heard? That really made you pause a little bit and think differently.

Matt Brown:

Yeah, so, I think that there’s a variety … I mean, I think the answer is just about every single person I’ve heard speak at this conference has given me pause to wonder about the future.

Lee Beck:

Yes, my notebook just keeps scribbling and scribbling.

Matt Brown:

I just keep having more and more notes, I’m like, “Wow.” It says the best idea, and then it keeps having more added to the list.

Lee Beck:

Yeah.

Matt Brown:

I think I want to go back to some of the predictive technologies that are being developed right now. We have used technology and artificial intelligence to predict future events. But when you predict future events, what you’re really doing is you are putting plans or have the ability to put plans in place in advance of an event.So you’re, often times, saving yourself a lot of headache, heartache, to be in the middle of a problem, as opposed to preventing it. I’ll give you an example. Wouldn’t we all rather know that we could have cancer, as opposed to finding out we have stage four cancer? Wouldn’t you rather know that a famine in Africa is on the way due to measuring food supply, as opposed to finding yourself in the midst of a famine? Wouldn’t you rather have a early warning on hurricane before the flooding and devastation of New Orleans? So, what’s sticking out here, what [inaudible 00:14:40] of the future of at this conference, the predictive ability, where technology plays a role in that. It’s not only, obviously, great for its own right, but the savings and human savings is enormous. So that has to be probably at the top of the list right now of the most exciting trends that I’ve seen today and yesterday.

Lee Beck:

Yeah, well, as I said, this is an exciting place, this is an exciting time. There was a comment made by … actually, I think it was [inaudible 00:15:13], talked about there was never a time he saw greater innovation taking place around the world, shared innovation. Truly unique, your company’s doing the same thing. No, I find this conference talking about the theory of shared prosperity, how can we consider this broadly? If there was one thing you could do to give advice to share prosperity broadly across the corporate America or global landscape, what would it be?

Matt Brown:

You know, it’s a big one. I almost put the question back at you, and see if you could help me answer it too, because I have a lot of thoughts on that.

Lee Beck:

You know what? I’m challenged by the balance here, because we can talk about this technology, the innovation, shared prosperity, but many of the discussions you’ve heard, also talk about I would say the reduction or the elimination of the middle person. What does that do from a labor market? You know, what do we do from a broad capital [inaudible 00:16:14] structure around the world? How is it going to displace many of these roles that we talk about becoming inefficient, and we can outsource them to technology? I’m challenged with the answer. How do we broader prosperity effectively, efficiently? But also talk about all this innovation and technology’s going to take away many of those roles that people had.

Matt Brown:

Right.

Lee Beck:

This balance is something I don’t have an answer for.

Matt Brown:

Yeah, so the human cost, I think is where you’re going to zero … potentially one area that you’re zeroing in. We think a lot about the human cost of technology innovation, you think about … just take your marketplace platforms that are democratizing anything, right?

Lee Beck:

Yes.

Matt Brown:

Talk about the fact that, you know, we are transforming how people attend sporting events, for example. You’re no longer going to walk in with a paper ticket, you’re going to walk in with maybe an eye scan, and they’re going to know who you are, and they’re going to know your shirt size, and they’re going to bring you that shirt. You can be able to follow your player on your phone that you’ve already programmed as your favorite player, and watch playback on just that player. So that technology personalization, but at what cost is the big question, and that is the evolving question. I think we are possibly, naively, still kind of hanging on to the fact that there’s not going to be a human cost to this, that we can reposition jobs. But the reality is, if you’re repositioning, that just means you’re temporarily doing something different, and you’re not going to be hiring that set anymore in the future.

Lee Beck:

Fair point.

Matt Brown:

So that is actually a reduction. But, you know, you look at the history of society, you look at the history of the United States, every single time we are tasked with a next step up, we’ve been better for it.

Lee Beck:

I’ll close with this one statement, which I was really surprised, I heard it the other day from the VC panel, that today there’s over 4.5 billion individuals with a smartphone. With $100 by the end of today, we could create our own website. Imagine the world they were living in today where you could reach, theoretically, 4.5 billion people after $100 investment in a website, immediately. Now, whether they search you out, find you, or other, it’s a further discussion. But there’s never been a time to actually democratize or position yourself as a firm there is today. With that said, it’s been really interesting to watch you grow and the business model evolve over time. So, continued luck and success.

Q. What is an Opportunity Zone?

An Opportunity Zone is an economically distressed community selected for revitalization and redevelopment by the Opportunity Zone program. The aim of the program is to stimulate private investment into disadvantaged areas that have otherwise been unable to attract investment by offering investors significant tax incentives.(1)

Q. How were Opportunity Zones Created?

Opportunity Zones were created by the Investing in Opportunity Act, a provision of the broader Tax Cuts and Jobs Act of 2017. (1)

Q. What is the purpose of Opportunity Zones?

Q. How were Opportunity Zones selected?

State and territory governors were empowered by Congress to nominate up to 25% of their state’s low-income community census tracts for inclusion in the Opportunity Zone program. A low-income community census tract is an area which has a poverty rate of at least 20 percent or where the median family income is less than 80 percent of the surrounding area. Additionally, governors were able to substitute up to 5 percent of their nominated tracts with tracts that may not have met the low-income standards, but which were contiguous with other nominated low-income community tracts. These nominated communities were then certified by the Treasury Department. (3)

Q. How many Opportunity Zones are there?

There are 8,762 Opportunity Zones. Of these, 8,532 are low-income community tracts and 230 contiguous communities.(2)

Q. How can investors access Opportunity Zones?

Investors can access Opportunity Zones by investing in an Opportunity Zone Fund (OZF). An OZF is an investment vehicle structured as a corporation or partnership that was formed specifically for the purpose of investing in qualified opportunity zone assets and that holds at least 90 percent of its assets in qualified opportunity zone assets.

Q. What are the incentives for investors to invest in Opportunity Zones?

There are three primary tax-based incentives associated with the Opportunity Zone program. They include:

Deferral of capital gains tax from other investments

A step-up in the basis of the capital gains invested into an Opportunity Zone based on the length of the holding period, and;

Tax free growth of the Opportunity Zone investment if it is held for a total of 10 years (2)

Q. What type of capital gains can be invested into an Opportunity Zone Fund (OZF)?

Both short- and long-term gains from the sale of stocks, bonds, property and interests in partnerships are eligible for investment in an OZF. (4)

Q. How long after realizing a capital gain do the proceeds from a sale need to be invested into an OZF?

Realized capital gains need to be invested in an OZF within 180 days. (2)

Q. What are the step-up rates on the deferred capital gain?

If an investment in an OZF is held for 5 years, the basis on the deferred capital gain is stepped up by 10 percent. If the investment is held for 7 years, the basis is stepped up by an additional 5 percent. The maximum step-up is 15 percent. (3)

Q. When are the taxes on the deferred gains invested into an Opportunity Zone investment due?

Taxes deferred through the program are due at the time the investment in an OZF is sold, or December 31, 2026, whichever is earlier. This means that taxes will likely be payable prior to the end of the fund life. (3)

Q. To receive the step-up rates on the deferred capital gain, when will an investment into an OZF need to be made?

Investors will receive the maximum step-up on the deferred gain after 7 years. Since the last date for paying taxes on the deferred gain is December 31, 2026, investors will need to be invested in an OZF by December 31, 2019 to realize the maximum step-up benefit of 15%. Failing to meet this deadline still leaves them eligible to receive the 10% step-up after 5 years and to receive this they will need to be invested in an OZF by December 31, 2021. OZF investments made after this will not qualify for the step-up in basis on the deferred gain but will qualify for tax free growth of the investment if held for at least 10 years. (2)

Q. What types of investments can be made under the Opportunity Zone Program?

Much of the focus of the Opportunity Zone program has been focused on real estate investments. However, under the program, eligible investments can include natural resources, manufacturing, transport hubs, etc. so long as they are in one of the qualified opportunity zones. (3)

Q. Are there any guidelines concerning the underlying investments made by an OZF?

Assets within an OZF must;

Be put to new use

Be substantially improved by investing at least the amount of the purchase price to further develop the site (excluding land)

Additionally, every six months an OZF is required to furnish the IRS with a list of Opportunity Zone assets that they have closed on or have signed a letter of offer. (4)

Q. What is the initial investment period of the OZF?

Once capital is called, the manager of an OZF must meet certain asset tests twice a year. Following these asset tests, the manager has 31 months to invest the proceeds. If this is not completed, the OZF will fail to qualify for the program and investors will not realize the programs associated tax benefits. (2)

Q. Can I continue to hold an OZF indefinitely to continue to benefit from the tax-free growth of the investment?

No. While an eligible investment will growth tax free once held for 10 years, the limit to an individual OZF is 20.5 years. (2)

Q. What are the risks associated with investing in an OZF?

Mercer outlined in their Opportunity Zones whitepaper (accessible to CAIS Members below). Briefly, their paper outlines the following risks;

Development: due to strict development guidelines, managers will need to have development experience and local relationship, in addition to skills in acquisition and transactions.

Quality: not all Opportunity Zones share the same relative attractiveness. There is likely going to be strong competition for the best quality opportunities.

Property Value: property prices will likely increase in response to the large anticipated capital inflows.

Supply of Capital: significant capital inflows may cause Opportunity Zones to be overdeveloped leading to inflated prices.

Exit-timing: the full tax benefits of the program will be realized after 10 years, after which time there could be a large capital outflow which could put downward pressure on prices. (2)

This document may not be distributed without the written consent of CAIS. It does not constitute an offer to sell, or the solicitation of an offer to purchase, any security or investment product and is not a complete description of the terms applicable to an investment in any fund or vehicle. Any such offer of solicitation may only be made by means of the fund offering memorandum. This information included herein is based on third party sources and may be revised without notice to the reader. The information above is for informational and educational purposes only and should not be relied in connection with any investment decision or for any other purpose whatsoever.

Wealth managers that hope to anticipate the implications of blockchain technology on their business must first clearly understand what a blockchain is. A blockchain represents a distributed ledger which records transactions using secure, encrypted blocks of data that each link to the prior block. The connections between this contiguous chain of data blocks are permanent, as is the transaction data recorded in the blocks themselves.

Thanks to strong encryption and the distributed nature of the blockchain, it could be cost-prohibitive to attempt to alter the blockchain connections or the data contained therein. This permanence or immutability creates a transaction record that can be distributed securely across many counterparties without fear of tampering. All users of the blockchain with the appropriate privileges can review the data stored in the blockchain, which may lower the overhead involved in accessing a centralized ledger (such as assets stored at a given custodian, for example) and make it an ideal vehicle for interactions between multiple counterparties where trust may be low or objective verification of data is needed.

Potential Relevance to Wealth Management

The most famous1 use of blockchain technology is the cryptocurrency Bitcoin, which relies on a distributed and secure blockchain ledger to achieve global reach and yet seeks to ensure asset privacy and integrity independent of the financial infrastructure of any world government or bank. While Bitcoin adoption is still far behind that of more traditional currencies, it has provided a potentially useful proof that the underlying blockchain technology works at scale. In addition, the appreciation of Bitcoin valuation has gained the attention of increasing numbers of investors2, suggesting that one of the most immediate uses of blockchain technology for wealth managers might be to use virtual currency as an alternative investment to further diversify the portfolios of their clients. Other rising cryptocurrencies such as Ether confirm that the age has arrived where investment portfolios can be comprised of digital assets, although solely doing so may not meet diversification goals as speculation and trailing regulation affect these currencies.

While virtual currency is the most tangible3 manifestation of blockchain technology thus far, the stage is set for more fundamental applications that could transform wealth management, such as:

Rapid client onboarding through the streamlined gathering of investment profile or Know Your Customer (KYC) data that is already securely stored in a blockchain;

Blockchain-based portfolios of assets could result in easier investment execution and communication between investors and wealth managers as portfolio preferences and changes become readily evident to both parties.

These are just some of the opportunities presented by blockchain technology that might alter the wealth management value proposition as operations and client service is streamlined, while also forcing potential reconsideration of revenue streams as transaction frictions and fees diminish. Of course, blockchain technology will likely encounter adoption challenges as it contends with the limitations of existing systems and relies on widespread adoption among counterparties to truly realize its full potential.

What Should Wealth Managers Do Now?

The enterprise technology advisory firm Gartner Group added blockchain to its famous Hype Cycle framework in 2016. The Hype Cycle is used to chart the adoption and maturation of emerging technologies, and Gartner pegged blockchain technology as being at the peak of expectations in the latter part of 2016. Technologies at that heightened stage of market exuberance inevitably begin to temper expectations as the technology jumps from the laboratory to meeting the varied demands and challenges of real world implementation, which is the transition that blockchain technology is beginning to make in 2017.

Given its transitionary state, wealth managers are advised to carefully monitor the maturation of this technology, as they have with other strategic technologies such as robo-advisors whose evolution took a different course than was anticipated in an earlier lifecycle phase. Wealth managers who wish to actively monitor and participate in the evolution of blockchain technology might consider the following:

Understand the Technology: Many sources of authoritative research on the theory and application of blockchain technology exist, including Gartner Group, CoinDesk and the new Blockchain Research Institute which was just launched in 2017 by futurist Don Tapscott.

Get Familiar with the Key Players: Bitcoin and Ethereum are the dominant cryptocurrency platforms, while firms such as Digital Asset Holdings are partnering with traditional financial institutions such as the DTCC to re-engineer the existing clearing and settlement infrastructure using blockchain technology.

Attempt a Proof of Concept (POC): If blockchain technology delivers on its transformative potential, those wealth management organizations with practical experience could be well-positioned to enjoy a first-mover advantage and therefore should consider trials of the technology. These trials could be as approachable as adopting virtual currency for transactions or even as an investment, or more ambitious such as signing on to be a participant in an industry consortium or working group such as the Stakeholder Working Groups being convened by DTCC.

3PwC. (2016, February). Making sense of Bitcoin, cryptocurrency, and blockchain. Retrieved from https://www.pwc.com/us/en/financial-services/fintech/bitcoin-blockchain-cryptocurrency.html

]]>Advice for Financial Advisors: Developing a Holistic Marketing Strategyhttps://www.caisgroup.com/blog/advice-for-financial-advisors-developing-a-holistic-marketing-strategy/
Tue, 27 Jun 2017 14:02:22 +0000https://www.caisgroup.com/?p=2021Read more]]>Independent financial advisors are often confronted with a host of questions as they build their business, such as:

Are my clients positioned to weather market volatility?

Are there other asset classes I should introduce to my client portfolios?

How will the DOL Fiduciary Rule affect my business?

These issues are critical for many advisors and demand time and attention, leaving wealth managers with less time to think about marketing and growing their businesses. In fact, the Investment News 2016 Financial Performance Study found that 54% of firms in the study failed to meet their growth goals. In today’s increasingly competitive landscape, a “set it and forget it” mentality may not produce the desired results when it comes to marketing goals.

Best practice suggests that those firms who take an active management approach across multiple channels will have the best chances of success1. Marketing is an ecosystem where all components perform better in totality than individually1. With that in mind, here are some guidelines to help financial advisors such as yourself to craft a marketing strategy and generate more leads:

Know Yourself

This may sound rudimentary, but when pressed to simply define what differentiates their firm from the competition, many wealth managers struggle to answer which suggests they have not taken the time to properly brand themselves. You should establish a clear value proposition that illustrates why clients should work with you. Perhaps your value proposition lies in specific subject matter expertise such as being an alternative investments specialist or that you focus on entrepreneurial clients. Once you have developed your value proposition, clearly and consistently communicate it across all of your messaging channels, whether that is your website, a press release or business cards.

Know Your Clients

Targeting high net worth clients simply isn’t enough – you should get to know each client in a personal and engaging manner as individuals. Is your client a business owner? Are you helping to preserve generational wealth? Does the client lead a flamboyantly affluent lifestyle or are they more understated? Does your client use a third party to manage introductions? These are the kinds of meaningful details that may be required to develop a successful relationship for the both of you.

You should also consider how you will find new clients, and that starts with understanding which customer segment you wish to serve. Are you targeting self-directed investors who may be working with a wealth manager for the first time, or are you targeting investors at large wire houses to help give them a more personalized experience? To help your prospecting efforts, build an Ideal Client Profile (ICP) – a complete persona of your best client beyond just a net worth number. This will guide you on who to target and help to increase your new client conversion rate.

Comprehensive Website

In today’s competitive landscape, a professional and robust website has become table stakes for any business. Fortunately, with the number of website platforms offering templated design and drag and drop editing, this has never been easier to achieve. A website should be comprehensive and designed to drive viewers deeper into information-rich internal pages rather than relying on a spartan home page with the bare essentials. A comprehensive website can afford you the opportunity to clearly communicate your mission statement and value proposition, define your services, and provide a forum for content and thought leadership. Most importantly, it serves as your “home base” to drive new prospects to in order to help build your credibility as well as serving as a mechanism to capture new prospect information.

Content is King

Engaging content can be used effectively to build brand awareness, strengthen loyalty and bolster client relationships. According to the Content Marketing Institute, 86% of brands outside of financial services are already employing a content marketing strategy, while 88% of financial services brands surveyed say that content marketing will become more important over the next 12 months. While the financial services industry has lagged behind in the content arena, even private equity firms are recognizing the importance of content marketing in their marketing strategy and ramping up their efforts, as reported by FUNDfire. Simply producing content is not enough, however. Firms should connect and build trust with prospects and clients. It can be helpful to concentrate on supporting the entire client journey with a range of content from educational material to added value content, rather than just sales oriented content. In a study conducted by The Financial Services Forum, only 13% of respondents specifically focus their content on sales while 71% focus on brand awareness and thought leadership.2 Remember, content can take different forms: blog posts, white papers, ebooks, podcasts, and video.

It’s Good to Be Social

Social media is another emerging channel in the wealth management industry. While Snapchat and Instagram may not prove to be valuable channels for your business, LinkedIn and Twitter can provide a platform to amplify your content and establish you and your firm as a thought leader. LinkedIn offers a range of free and paid services to help you reach your prospect generation goals. Posting content via LinkedIn Pulse can broaden the reach of your content beyond your current network. For a fee, you can directly target prospects that look exactly like your ICP. As with all forms of marketing, please remember to adhere to the regulatory and compliance guidelines appropriate to your business; the real time interaction that occurs on social media can sometimes make that easy to forget.

Events

Events can be a very effective way to network and initiate face to face conversations with potential prospects. It may not be necessary for your firm to go through the time and expense of hosting your own event, but you should be aware of relevant industry events and plan to attend and perhaps even be a featured speaker. Providing your expertise in a speaking engagement can help to solidify your thought leadership in the field. Always plan each event and have well-defined goals and strategies in place to make the most of each event and to facilitate calculating a return on your investment.

Referrals

While referrals are no longer the primary driver of AUM for wealth managers3 they can still have their place within a marketing strategy if applied with an innovative twist. Many high net worth individuals utilize a third-party professional, such as an attorney or CPA, to facilitate professional introductions. Forming a strategic partnership with other professionals in your area to recommend your services has proven to be effective; for example, if your ICP includes business owners, partnering with a CPA may be a beneficial relationship. It may take time to build the trust and credibility to secure these partnerships; speaking at industry events, maintaining a social presence and fostering your thought leadership through content will all aid in the process.

The Last Mile

Once you have begun to execute your marketing strategy, don’t forget to track and measure your success. 62% of firms studied do not track the leads they generate. They do not know how many leads they had last year, nor from where those leads came from.3 This lack of awareness results in a huge missed opportunity for any firm, and so you should have an inbound lead process with corresponding metrics established before you begin to implement your strategy. Many firms designate 1 person to qualify inbound leads; once qualified, a new lead can be forwarded to the appropriate wealth manager for follow up or nurtured with additional content. Qualified leads convert to new clients, and every advisor wants the opportunity to serve new clients.

]]>Cybersecurity Best Practices for Wealth Managers and Fintech Platformshttps://www.caisgroup.com/blog/cybersecurity-best-practices-for-wealth-managers-and-fintech-platforms-2/
Wed, 17 May 2017 20:43:51 +0000https://www.caisgroup.com/?p=2008Read more]]>The global ransomware attack known as WannaCry has affected consumers and businesses in more than 150 countries this month and has captured the collective consciousness for the moment. As such, it presents an opportune time for the wealth management community and the fintech platforms they rely on to reflect on the current state of cybersecurity. The current state of cybersecurity represents an escalating arms race for both hackers and their targets, with the arsenal of tactics and countermeasures employed evolving at a dizzying pace in a 21st Century Cold War where détente is likely the best outcome that is currently possible.

The WannaCry attack is simply the latest manifestation of a sobering state of affairs that has been unfolding for some time for financial institutions, fintech platforms, and financial advisors. According to the 2017 SonicWall Annual Threat Report which was released in February 2017, the rate of ransomware attacks in 2016 had increased 167 times over 2015. This explosive growth can in large part be attributed to the aggressive growth of the device-oriented Internet of Things during the same period, which provides hackers with many more attack targets. In addition, the availability of bitcoin provides a ready means for attackers to monetize their endeavors in an untraceable manner via ransoms paid in bitcoin. The SonicWall Annual Threat Report indicates that of the 638 million ransomware attacks attempted in 2016, 13% were directed against the financial services industry.

Ransomware is but one form of cyberattack, but as with many types of crime, hackers generally want to follow the easy money and maximize their return for the least possible effort and risk of detection. As a result, a core set of best practices can be followed by fintech platforms and wealth managers alike to become less susceptible targets. The following list of best practices can help:

Establish an Information Security Policy: A thorough information security policy sets the standard for an organization to follow with respect to security practices and compliance. It should reflect relevant industry guidelines, such as those provided by FINRA.

Build Cybersecurity Awareness: Security policies are only effective if they are understood and put into practice. Conduct annual cybersecurity awareness training that is mandatory for all personnel in order to train them regarding how to identify and respond to common cybersecurity threats (ie. never open links or attachments in emails from unknown sources, etc.)

Proactively Manage Patches: Establish a patch management policy for all company computers and devices. All operating system patches that address severe risks should be evaluated and installed right away. Inertia is the hacker’s ally; a patch for the operating system exploit used by the WannaCry attack had been available since March 2017 and yet had not been applied to a large number of computers around the world when the attacks began in May.

Be Mindful of Device Management: In addition to a patch management strategy, all company devices should have the latest antivirus protections, standard configurations, and well-defined administrative controls. Consider how to remotely wipe a device if it should be lost, rather than risking it becoming an asset for an attacker to use.

Encrypt Devices and Sensitive Data: Sensitive data should be encrypted both in transit over networks as well as at rest on servers. All laptops and desktops should have full disk encryption to protect sensitive data should the device be lost, which is common for laptops.

Protect Information Wherever It Resides: Information need not be in a digital format to be compromised. Enforce clean desk policies. Never write down passwords, and store them only in a secure place.

Make Sure Passwords are Not as Easy as 1-2-3: Strong/complex password guidelines should be established and enforced. This should be coupled with active password rotation which expires passwords and forces them to be reset at least every 3 months. Users may chafe at these practices, but not more than if they get hacked.

Actively Manage Vendors: Many systems (such as Home Depot’s in 2014) are compromised using hacked vendor systems as the initial point of attack. Create a third-party vendor questionnaire to make sure that all vendors meet minimum security standards, and have all third-party vendors sign confidentiality agreements. Consider vendor contracts with security provisions to provide legal recourse in the event of a breach.

Conduct Regular, Comprehensive Backups: Make sure that systems are backed up frequently (ideally daily) with a private encryption key and be sure that the scope of data that is backed up is sufficient to restore the business to full operation in the event of an emergency. Effective backups are one of the best defenses against ransomware attacks like WannaCry.

Don’t Overshare: Establish a social media policy and train staff members to protect their personal information on social media. Information disclosed via social media can be used by hackers to conduct social engineering, which are tactics used to dupe targets through familiarity or social pressure. Do not re-use the same personal security questions for any system that is work-related; a favorite sports team used as a security answer could easily be deduced from social media for example.

CAIS is committed to the security of both our own platform as well as the registered independent advisors (RIAs), independent broker-dealers (IBDs) and family offices that we serve with our platform; to that end, we will explore the topics in the above cybersecurity best practices as well as related security topics in greater detail in future blog posts.

The first few months of Donald Trump’s presidency have produced some controversy, to say the least. And while the U.S. equity markets have largely responded positively thus far since the change in leadership, there is uncertainty about what some of the changes being proposed by the Trump administration will mean for both the U.S. economy and markets worldwide on a long-term basis. Given such uncertainty, the role that hedge funds play in portfolio diversification is more important than ever1 and is evidenced by the fact that total hedge fund industry capital increased to a third consecutive quarterly record in the first quarter (1Q17), according to the latest HFR Global Hedge Fund Industry Report. There are a number of factors that the hedge fund industry will be watching closely as 2017 progresses – from increasing protectionism in countries such as the UK and France to changing demographics in China and even changing investor sentiment regarding investment in hedge funds2.

Domestic Policy Influences

One change to come about with the new administration is Republican control of both Congress and the Senate –a shift that could potentially result in an easing of Wall Street regulations. President Trump has vocally promised to disassemble the Dodd-Frank Wall Street Reform and Consumer Protection Act of 20103. Given some of the appointments he has already made to his cabinet, and the dismissal of high profile regulators such as Preet Bharara – the U.S. attorney for the Southern District of New York who aggressively prosecuted several high-profile hedge fund firms4 – a number of experts predict that the Volcker Rule, which prohibits banks from proprietary trading, could well be eliminated5. Similarly, the Trump administration is campaigning for a more business-friendly environment to spur job creation with tax breaks that favor businesses, according to the Tax Policy Center in Washington, D.C. One exception that may be worth noting, however, is President Trump’s criticism of carried interest and his promise to end the controversial tax treatment6. Presently, carried interest enables the long-term gains of investment managers to be taxed at the capital gains rate, which is lower than what they would otherwise be required to pay. While more of an issue for private equity funds, where long-term investments are standard practice, carried interest is still utilized by many managers within the hedge fund industry6.

While any policy changes put in place by the Trump administration are anticipated to be favorable for specific sectors such as financial, construction and infrastructure-oriented businesses, they have the potential to be equally harmful to others7. Take, for instance, the aerospace and defense industry. Prior to taking office, President Trump announced that he would nix a government contract with Boeing to replace the current Air Force One planes –news that substantially impacted the stock prices of Boeing and companies involved throughout the supply chain8. Though the Trump administration has since changed its position with Boeing, their criticism of the North Atlantic Treaty Organization defense fund has left investors wary of President Trump’s promises of protectionism9.

With President Trump, having taken an extremely anti-trade position during campaigning, including promises to eliminate the North American Free Trade Agreement among other policies favorable to trade between the U.S. and other major economies9, there are fears about what it would mean for markets if the Trump administration follows through with some of these threats. The ‘Buy American, Hire American’ executive order signed by President Trump in late April suggests that protectionist inclinations are indeed more than just campaign rhetoric. The side effects of protectionist policies can be unintended, such as potentially being harmful to U.S. businesses or industries heavily reliant on trade, not to mention the impact on global markets as well. Though emerging market equities seem to finally be on an upswing that is expected to help the performance of hedge funds focused on the strategy, a recent report from Mercer, “Economic and Market Outlook 2017 and Beyond,” notes that any efforts by the Trump administration to impose tariffs on countries such as Mexico and China could not only hurt those countries but the global economy as well. Of course, protectionism is by no means limited to the U.S. – a reality that both emerging market and global macro fund managers should be well aware of.

Global Macro Influences

British Prime Minister Theresa May has triggered Article 50 of the European Union’s Treaty on Lisbon, which is the process that member states must use to withdraw from the EU and which has set in motion a two-year countdown during which time the UK must negotiate the specifics of how Brexit will occur. “2017 Investment Themes and Opportunities,” another recent report from Mercer, predicts weak UK economic growth in 2017, given uncertainty about how Brexit will play out. Meanwhile, 2017 elections in both France and Germany, both of which have candidates who have indicated desires to either leave the EU or review their countries commitments to the single currency10, could lead to currency volatility – creating opportunities for global macro managers or strategies involving active currency hedging.

Another country that fund managers will continue to actively watch in 2017 is China. In January, following seven straight months of declines, China’s reserves of U.S. dollars fell to just above the $3 trillion mark, the lowest point for its foreign reserves since February, 201111. While President Trump has backed away from his initial claim that China has been a currency manipulator12, fears of trade restrictions still loom. As the world’s second largest economy and the United States’ largest trading partner, trade restrictions could undermine global equity returns1.

Monetary Stimulus

In the meantime, following several years of quantitative easing, the Fed and the European Central Bank have both indicated their belief that it is time to start dialing back their purchasing of government securities as a way of trying to boost their respective economies13. As such, rising interest rates are expected to significantly influence the U.S. market in 20171. In mid-December 2016, the Fed raised its key interest rate by 0.25%, followed by another 0.25% rate hike in mid-March. And with signs pointing to a strengthening economy, the Fed has indicated that it expects to raise rates another two times this year12. With quantitative easing finally coming to an end, bond yields are likely to increase and the markets are expected to become more volatile1. Meanwhile, though the Bank of Japan has said it is not yet ready to scale back that country’s quantitative easing efforts, there is no longer unanimous agreement among the members of its policy board that it should continue with the practice and economists believe Japan will soon be forced to follow the lead of the Fed and the ECB12. With the promise of inflation and rising interest rates in 2017, multi-strategy and macro managers could expect to have opportunities in asset-backed securities, corporate debt, and even high-yield debt1.

Potential Opportunites For Growth

Whether or not specific hedge fund strategies perform as predicted in 2017, one thing that has become clear is that hedge fund firms need to become more investor friendly. In 2016, hedge fund investors redeemed a total of $102 billion, according to data from Preqin. High management fees, lack of transparency, and better alignment of interests were the key reasons cited for the redemptions14. And with a December 2016 Preqin survey revealing that 38% of investors plan to decrease their hedge fund allocations in 2017, many managers have already begun to address the key issues by lowering fees and implementing transparency and alignment strategies. In addition, 75% of managers surveyed say they would be willing to reduce fees in the coming year15.

Given many of the changes taking place in the U.S. and abroad, 2017 continues to have the potential to provide opportunities for many hedge fund strategies. According to the latest HFR Global Hedge Fund Industry Report, total hedge fund industry assets increased $47.2 billion or 1.6% in the first quarter this year as investors increased allocations to event-driven and quantitative, trend-following systematic macro strategies. Investor outflows in the first quarter were at their lowest levels since 4Q152. Mercer Investment Management still finds a compelling foundation for alternative investments due to their low correlation to traditional asset classes and expects hedge funds to generate net-of-fee returns well in excess of cash1. Given this momentum, independent wealth managers should carefully monitor and consider how hedge funds might help their client portfolios navigate these uncertain times.

This document may not be distributed without the written consent of CAIS. It does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product and is not a complete description of the terms applicable to an investment in any fund or vehicle. Any such offer of solicitation may only be made by means of the fund offering memorandum. This information is based upon information that may be revised without notice to, or the consent of, CAIS, the administrator of the relevant fund, such fund, or any of their respective employees, officers, members, partners or affiliates (or any employee, officer, member or partner of any such affiliate). Furthermore, the above information shown, including any performance information, may be based on estimates provided by third parties (i.e., other than CAIS or any CAIS affiliate). The performance information shown reflects investments made in markets characterized by certain events that may not occur in the future. A fund may calculate metrics similar to those shown in performance information using unrounded numbers and/or monthly returns that are slightly different from those sent to investors in such fund. As a result of the foregoing, it is possible that there may be differences between the data in the information shown and the information provided by a fund and/or its investment manager. While neither CAIS nor its affiliates expect that such differences will be material, no assurance can be given that any fund referenced herein will be available for investment. The metrics displayed may not provide an accurate portrait of the potential risks involved in investing in any portfolio, fund, any CAIS fund or any group of CAIS funds.

Distressed debt and credit is a comparatively small but growing sector of the private equity and hedge fund market with approximately $250B in AUM spread across approximately 120 US based funds1. The sector is focused on investment opportunities that involve any credit instrument that is trading at a significant discount with a greater than average spread for its industry. A substantial number of these opportunities represent securities that are in outright default and as a result, the investment takes the form of loans or bonds intended to aid companies facing significant challenges2. These distressed securities are, therefore “below investment grade” as the distressed organization is usually in or near bankruptcy2.

Investment Strategies

There are several types of strategies employed within the distressed space. It should be pointed out that while each strategy is distinct, many funds utilize a hybrid of strategies in some form of combination as the marketplace and opportunities dictate2:

Distressed Debt Trading:

At its simplest, Distressed Debt Trading involves purchasing debt obligations which are trading at a distressed level in anticipation of reselling those securities over a relatively short period of time at a higher valuation, generating a trading profit. Funds employing this strategy are generally looking for investment opportunities in which they believe the debt obligations are mispriced and will rebound in value. The holding period on this type of investment is typically short and measured in weeks or even days, which makes this strategy the most liquid in the class.

Distressed Debt Active/Non-Control:

Active/Non-control strategies are substantially different from trading strategies in that the goal for the fund manager is to accumulate significant positions in companies that are likely to go through, or are in, a bankruptcy restructuring process. The goal is to gain a position of influence in the bankruptcy negotiations with the possibility of maximizing returns. This is a generally complex procedure that necessitates a longer holding period as well as a larger, more concentrated position.

Distressed Debt Control:

In this strategy, a fund manager builds a controlling position in the fulcrum distressed security in a bankruptcy proceeding to effectively buy control of the target company. With this strategy, the distressed debt position is in many respects the start of a much longer process, as after the fund manager wins control of the target he would typically begin the process of maximizing profitability either through restructuring, merging, or liquidation.

Distressed Credit Restructuring/Turnaround:

Distressed credit funds also buy suffering target companies utilizing equity, sometimes purchasing them before an expected bankruptcy and other times during the bankruptcy process. The goal is to gain control of companies that are under par value and then restructure them.

Both Private Equity and Hedge Funds compete within the distressed space. Many funds employ a hybrid approach to more effectively utilize multiple strategies and be more opportunistic in the marketplace3.

Why Distressed Credit?

Distressed investments are counter-cyclical to buyouts: an expanding credit bubble generally enables an expansion of buyout valuations; a recession tends to cause a drop-in borrower cash flow, and this leads to defaults on the mountain of debt. Distressed funds are positioned to buy debt, take the borrowers through a capital restructuring, and benefit from the eventual economic recovery. This should provide diversification throughout the portfolio4.

Acquiring debt or equity below par value creates a potential for greater returns. Investors in distressed debt can become major creditors in a company and could have significant influence during any liquidation process or reorganization that may take place. Investors in distressed credit potentially benefit from an increase in valuation above par after a restructuring and turnaround.

The promise of great reward comes with risk, especially given that the quality and volume of distressed debt opportunities is highly cyclical and that the window for outsized returns can be short. A useful way to understand the risks and return drivers of various investments can be to categorize their exposure to various base market exposures. Defining, measuring or scoring some these risk factors can improve an investor’s ability to properly judge the risk and potential return of different portfolios. Mercer’s model of factor exposures is shown below5:

Considerations for Wealth Managers

When considering the role that distressed opportunities may represent for client portfolios, we believe wealth managers should balance the illiquidity premium and portfolio diversification opportunities presented by the asset class. Distressed strategies require an experienced and active hand to navigate effectively, and wealth managers should bear that in mind as they perform due diligence on the asset managers to which they are entrusting their client assets. The following characteristics may be helpful to keep in mind when assessing a distressed debt and credit fund:

Track record that demonstrates experience managing distressed debt and leveraged loans and confirms a deep understanding regarding how to navigate an issuer through the process of bankruptcy and associated restructurings;

Appreciation for the cyclical opportunities that can arise in the distressed sector and the liquidity to take advantage of those opportunities;

Intimate knowledge of the factors contributing to a specific issuer’s distressed condition as well as the issuer’s capital structure across all credit and loan facilities and corresponding opportunities;

Robust understanding of the industries, operational norms and competitive landscape of the issuers in the fund’s portfolio.

This document may not be distributed without the written consent of CAIS. It does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product and is not a complete description of the terms applicable to an investment in any fund or vehicle. Any such offer of solicitation may only be made by means of the fund offering memorandum. This information is based upon information that may be revised without notice to, or the consent of, CAIS, the administrator of the relevant fund, such fund, or any of their respective employees, officers, members, partners or affiliates (or any employee, officer, member or partner of any such affiliate). Furthermore, the above information and commentary should not be relied upon for any purpose whatsoever. The information shown, including any performance information, may be based on estimates provided by third parties (i.e., other than CAIS or any CAIS affiliate). The performance information shown reflects investments made in markets characterized by certain events that may not occur in the future. A fund may calculate metrics similar to those shown in performance information using unrounded numbers and/or monthly returns that are slightly different from those sent to investors in such fund. As a result of the foregoing, it is possible that there may be differences between the data in the information shown and the information provided by a fund and/or its investment manager. While neither CAIS nor its affiliates expect that such differences will be material, no assurance can be given that such differences will not be materially significant. No assurance can be given that any fund referenced herein will be available for investment. The metrics displayed may not provide an accurate portrait of the potential risks involved in investing in any portfolio, fund, any CAIS fund or any group of CAIS funds.

As the first quarter nears its end the latest research, outlined below, suggests that there are mounting trends in alternative investments that may influence how financial advisors leverage the asset class through the remainder of the year for their clients.

The alternative investments asset class is now bigger than it has ever been, representing a total of $7.7 trillion invested in hedge funds and private capital according to Preqin’s Investor Outlook: Alternative Assets, H1 2017. In the broadest definition, alternative investments generally represent those investable assets that fall outside of the common stocks, bonds, and cash categories. Preqin’s analysis focused on institutional investor activity in six main alternative asset classes: hedge funds, private equity, real estate, infrastructure, private debt and natural resources.

Investments in the alternative asset class experienced growth of $300 billion in 2016, which according to Preqin is largely representative of an increasing diversification of alternative investment portfolios among existing alternatives investors as opposed to an influx of new investors. Preqin’s Investor Outlook study demonstrates that 80% of respondents are invested in at least one alternative asset class and that 34% are exposed to four or more asset classes. This diversification has grown since 2016 when Preqin found that only 25% of investors were invested in four or more alternative asset classes.

Given the increasing trend toward diversification within alternative investments, the same Preqin research offers insight into how investors are allocated among the alternative asset classes, with real estate (61%), private equity (57%) and hedge funds (51%) representing the greatest proportion.

For purposes of comparison, the top 3 alternative asset classes cited by Preqin were also the most popular alternative asset classes cited in the 2016 CAIS Independent Wealth Manager Survey, although in that survey 77% of respondents expressed interest in hedge funds, followed by 66% in private equity. Real estate and private debt were represented as subsets of private equity in the CAIS survey with a corresponding interest of 51% and 47% respectively. The Preqin and CAIS data both suggest that investor attitudes toward private equity, hedge funds and real estate are changing and therefore bear closer examination.

Private Equity

According to Preqin, investor satisfaction with private equity was 84%, the largest proportion among the alternative asset classes. Not surprisingly, 48% of investors intended to increase their private equity allocation over the longer term, and 83% intended to make their next commitment in the first half of 2017. The main concern expressed by 70% of the private equity investors surveyed focused on high valuations and the possible risk that fund managers might overpay for assets that could be difficult to realize if prices fall at a later date.

Mercer Investment Consulting’s position on private equity, according to Mercer’s Economic and Market Outlook 2017 and Beyond, isthat private market asset classes can offer a range of attractive opportunities for investors with a tolerance for some illiquidity in their portfolios. While some investors have sought to leverage the asset class to enhance returns, improve income yield and provide better diversification in their portfolios amid an opportunity set that Mercer asserts remains robust, they also caution that investors should diversify risk concentrations such that their private market exposures are not overly concentrated in certain areas of the market that are receiving an inordinate amount of investment.

Private Real Estate

According to Prequin, 93% of real estate investors stated that their real estate investments had met or exceeded their expectations in 2016. Preqin’s 2017 Global Real Estate Report indicates that in the three years leading up to June 2016, private real estate funds have generated an annualized 14.9% return; this is likely why 42% of investors indicated that their expectations had been exceeded over a three-year period, the highest such endorsement among all alternative asset classes.

Much like private equity, Prequin asserts that investors are concerned with asset pricing as one of the challenges of a crowded marketplace. Fundraising saw a modest decline in 2016, from $123B to $108B, and investment activity also slightly declined; 24% of investors surveyed by Preqin indicate that they will reduce their capital allocated to real estate in 2017. However, the opportunity for growth in the real estate asset class remains substantial, with 48% of investors indicating that they are below their target allocation; the average allocation was 8.9% with an average target allocation of 10%. 75% of investors indicated that they preferred to enter the asset class through private real estate funds, although 63% would not invest in first-time funds.

In a year which saw hedge fund assets exceed the $3 trillion milestone for the first time ever, data would suggest that 2016 proved to be a challenging year for hedge funds with a similar set of challenges poised for 2017. According to Preqin, investor satisfaction is low, with 66% indicating that hedge fund investments had not met expectations. Preqin asserts that only 20% of investors intend to increase their exposure to hedge funds in 2017, with performance and fees being the main concerns expressed by 73% and 64% of the respondents respectively.

According to Mercer’s Economic and Market Outlook 2017 and Beyond, the strategic rationale for alternative strategies involving hedge funds remains compelling after 8 years of stellar returns for the bond and equity markets. Mercer expects hedge funds to generate net-of-fee returns well in excess of cash and prefers strategies that exhibit low correlation to traditional asset classes. Mercer states that particular opportunities for macro-oriented strategies should be created given the uncertainty in terms of trade, currency, and central bank policies.

As investors diversify their alternative asset portfolios, a challenge felt by some investors across almost all alternative asset classes was that it is more difficult to source attractive investment opportunities than it previously has been.

This concern is manifested in different ways in the asset classes explored above, namely in the valuation concerns expressed for private equity, asset pricing concerns expressed for real estate, and performance and fee concerns expressed for hedge funds.

This document may not be distributed without the written consent of CAIS. It does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product and is not a complete description of the terms applicable to an investment in any fund or vehicle. Any such offer of solicitation may only be made by means of the fund offering memorandum. This information is based upon information that may be revised without notice to, or the consent of, CAIS, the administrator of the relevant fund, such fund, or any of their respective employees, officers, members, partners or affiliates (or any employee, officer, member or partner of any such affiliate). Furthermore, this above information and commentary should not be relied upon for any purpose whatsoever. The information shown, including any performance information, may be based on estimates provided by third parties (i.e., other than CAIS or any CAIS affiliate). The performance information shown reflects investments made in markets characterized by certain events that may not occur in the future. A fund may calculate metrics similar to those shown in performance information using unrounded numbers and/or monthly returns that are slightly different from those sent to investors in such fund. As a result of the foregoing, it is possible that there may be differences between the data in the information shown and the information provided by a fund and/or its investment manager. While neither CAIS nor its affiliates expect that such differences will be material, no assurance can be given that such differences will not be materially significant. No assurance can be given that any fund referenced herein will be available for investment. The metrics displayed may not provide an accurate portrait of the potential risks involved in investing in any portfolio, fund, any CAIS fund or any group of CAIS funds.

In CAIS’s view, financial advisors that wish to introduce real estate opportunities to the portfolios of their ultra-high-net-worth clients should be aware of more important considerations than the old adage “Location! Location! Location!” would suggest. Interest in private real estate funds is growing according to data provider Preqin, whose upcoming 2017 Preqin Global Real Estate Report indicates that 25 percent of investors will commit more capital to private real estate funds in 2017, which represents an increase from the 18 percent of investors that felt that way in 2016.1 Preqin asserts that 93% of investors state that the performance of their real estate portfolios met or exceeded expectations in 2016, and 36% of investors interviewed intended to increase their private real estate investments over the long term; in fact, 48% are below their target allocation for real estate.2 As a result, CAIS believes that wealth managers need to be informed regarding the market trends and strategies associated with private equity and private debt real estate opportunities to seek to leverage this asset class to their clients’ benefit.

Market Conditions and Real Estate Funds

The environment for private real estate that was observed in 2016 may have been as good as it gets to fuel the growth of private real estate investing, according to investment advisory firm bfinance.3 The firm contends that the repercussions of the Global Financial Crisis have continued to be felt by the banking sector in the form of increased regulation and capital adequacy concerns, which has reduced lending capacity from banks at a time when investor demand has continued to grow. bfinance cites macroeconomic factors for accelerating this demand, where the ‘lower for longer’ scenario for global interest rates that was perpetuated by monetary intervention, low inflation and weak economic growth has motivated investors to search for yield.

Private lenders have stepped in and addressed some of this investor demand. According to Preqin, $88bn was raised by 178 funds closed by December 2016 and there was $239bn available in dry powder to private real estate fund managers at that time, up from $210bn in December 2015. 60% of those funds closed in 2016 achieved or exceeded their target.

Private Equity and Private Debt Real Estate Strategies

Private real estate funds generally provide ultra-high-net-worth individuals and institutional investors with access to investable property assets not available on public trading indices. A private real estate fund generally uses pooled capital from multiple investors to spread across numerous properties and projects. Funds can encompass equity (ownership and rent opportunities) or debt (loan or mortgage opportunities) investment vehicles and employ a variety of strategies. Mercer’s private real estate educational materials, available on the CAIS platform, indicate that the most common strategies include Core, Value-Added and Opportunistic strategies, as outlined below:4

Core: These private real estate strategies are generally more conservative and focus on equity investments in stabilized, well-leased properties. They generally involve low leverage and a long-term hold time horizon that is typically 5-10 years.

Value Added: These strategies generally focus on properties requiring redevelopment or repositioning for alternate use or upgrades. They generally involve moderate leverage and as such offer moderate returns with an intermediate hold time horizon, typically of 3-5 years.

When investing in private debt-based real estate instruments, an investor generally acts as a lender to the property owner or deal sponsor. According to Mercer, several debt capital structures are available as follows:4

Mezzanine Loan: This structure typically involves a loan-to-value (LTV) ratio of 60-85% with a fixed or floating interest rate. The collateral is a pledge of the owner’s equity interest in the property.

B-Note: This structure typically involves a loan-to-value (LTV) ratio of 50-75% with a fixed or floating interest rate. The collateral is a mortgage on the property.

Senior Loan: This structure is the most secure option and typically involves a loan-to-value (LTV) ratio of 0-60% with a fixed interest rate. The collateral is generally the property itself.

Private Equity Real Estate Structures

A private equity real estate investment represents a shareholder ownership stake in the property. Investor earnings are proportional to the amount invested and returns are typically realized as a result of:

Income streams that an investment property generates, such as rent.

Increases in property value over time that are realized in a sale.

According to Mercer, the following equity capital structures are available:

Equity: This structure equates to owner’s equity of 75-100%. This equity is first at risk in default.

Preferred Equity: This structure typically involves a loan-to-value (LTV) ratio of 80-100% with a fixed or floating interest rate. The collateral is unsecured.

Summary of Portfolio Considerations

Diversification due to low correlation with other asset classes, relatively high and stable returns, and the ability to hedge against inflation are the most common reasons to introduce private real estate products into a portfolio according to Mercer. CAIS believes that these considerations should be balanced with the fact that liquidity is not always readily available however. Savvy wealth managers that are contemplating private equity-based or private debt-based real estate opportunities for their clients should conduct extensive due diligence on the funds under consideration as well as build an awareness of market shifts and trends.

This document may not be distributed without the written consent of CAIS. It does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product and is not a complete description of the terms applicable to an investment in any fund or vehicle. Any such offer of solicitation may only be made by means of the fund offering memorandum. This information is based upon information that may be revised without notice to, or the consent of, CAIS, the administrator of the relevant fund, such fund, or any of their respective employees, officers, members, partners or affiliates (or any employee, officer, member or partner of any such affiliate). Furthermore, this above information and commentary should not be relied upon for any purpose whatsoever. The information shown, including any performance information, may be based on estimates provided by third parties (i.e., other than CAIS or any CAIS affiliate). The performance information shown reflects investments made in markets characterized by certain events that may not occur in the future. A fund may calculate metrics similar to those shown in performance information using unrounded numbers and/or monthly returns that are slightly different from those sent to investors in such fund. As a result of the foregoing, it is possible that there may be differences between the data in the information shown and the information provided by a fund and/or its investment manager. While neither CAIS nor its affiliates expect that such differences will be material, no assurance can be given that such differences will not be materially significant. No assurance can be given that any fund referenced herein will be available for investment. The metrics displayed may not provide an accurate portrait of the potential risks involved in investing in any portfolio, fund, any CAIS fund or any group of CAIS funds.

]]>Hedge Fund Reflectionhttps://www.caisgroup.com/blog/hedge-fund-reflection/
Fri, 30 Dec 2016 19:56:47 +0000https://www.caisgroup.com/?p=1823Read more]]>Over the past few decades, hedge funds have transitioned from being obscure investment vehicles to an increasingly well-known investment vehicle as demonstrated by growth in assets under management. Global assets under management within the alternative investment industry totaled $7.4 trillion in the first half of 2016, according to data provider Preqin. As a subset of the alternative investments category, hedge fund assets surpassed the $3 trillion milestone for the first time by YE 2016 according to the HFR Global Hedge Fund Industry Report. As some institutional investors such as public pension plans have struggled to make up significant shortfalls in the amount of money they are legally required to pay out to retirees, many have turned to hedge funds over time in search of higher returns for the money they invest1. In markets where straightforward debt or equity investments can make generating returns extremely difficult, such as the lingering low-interest rate environment that has existed since the 2008 credit crisis, hedge funds may provide investors with an alternate investment path as well as an added means to diversify overall portfolio risk. 2016 has proven to be a year which has seen both meaningful outflows from hedge funds as well as record levels of invested assets2. As such, we believe the year serves as an important reminder for independent financial advisors to reflect on their understanding of hedge funds as an investment opportunity that might serve their clients’ goals, as hedge funds are no longer the sole province of institutional investors.

Like mutual funds, hedge funds typically use the pooled capital of multiple investors to create a single diversified investment portfolio focused on generating the largest possible returns for the individuals that have invested in them. Though there is a range of investment strategies employed by hedge funds, the one thing that generally ties many of them together is the practice of hedging – using one investment position to offset the potential losses of another position while reducing an investment portfolio’s overall risk in the process.

Through the practice of hedging, hedge funds generally seek to avoid correlation with standard market indices like the S&P 500. If the equity market experiences volatility that causes a downturn, the impact to the hedge fund’s performance may not be as severe and in fact performance might improve if negative correlation to the equity markets was the intent of the fund’s strategy. In this manner, hedge funds can provide balance and diversity across portfolios containing diverse asset classes, particularly those of high net worth clients.

Unlike mutual funds, which generally must adhere to strict limitations on the amount of risk (or leverage) that they can take within their investment portfolios, hedge funds can typically exercise discretion over their investment allocations and are therefore able to use far more sophisticated and aggressive investment approaches in their quest for higher returns. The most basic hedge fund strategy is long/short equity, where a fund manager will take long positions in stocks that they expect to increase in value, while at the same time taking short positions in stocks expected to drop in value. By altering the balance of long and short positions within a portfolio, a fund manager generally seeks to control a fund’s overall exposure to market risk. The types of hedges employed by fund managers run the gamut, from the previous example to the use of more sophisticated financial instruments such as the use of put or call options, derivatives, commodities and futures contracts, among others. Some hedge funds also employ large amounts of leverage; in exchange for assuming greater levels of leverage or risk, hedge fund investors expect to be rewarded with higher returns than those generated by the average mutual fund or market index. Due to that added risk, the Securities and Exchange Commission only allows investments in hedge funds to be made by investors that meet specific criteria. One category of investor in this regard is the accredited investor, which includes an individual with a sophisticated understanding of investing and whose net worth is in excess of $1 million, excluding their primary residence, among other qualifications. A more stringent category of investor typically required by hedge funds is the qualified purchaser, which includes an investor who owns not less than $ 5,000,000 in investments. Hedge fund investors also need to be prepared to agree to lockups –periods of time during which they are unable to redeem their investment so that fund managers have the time to put money to work in illiquid investments without the need to sell at less than optimal prices in order to meet redemption requests.

While the record levels of capital invested in hedge funds is a positive indicator, for many, 2016 was a challenging year in which overall performance was inconsistent. Despite fund managers’ best efforts to hedge against risk and potential market downturns, there can be a wide variance in the performance of different hedge fund investment strategies. In their search for better returns amidst varying market conditions, some fund managers strayed from their core strategies with mixed results. As an example, in the first quarter of 2016, Preqin’s All-Strategies Hedge Fund benchmark index recorded a loss of -0.43%. Fortunately, certain strategies managed to do well and the hedge fund industry’s overall performance has consistently improved since, with the Preqin’s All-Strategies Hedge Fund benchmark returning 2.15% for the second quarter of 2016, and 4.0% for third quarter 2016. While many hedge funds once again seem to be on an upswing, some institutional investors decided to decrease their hedge fund exposure in 2016, although we believe the record level of hedge fund assets recorded in 3Q2016 demonstrates that performance gains have outmatched asset outflows. Many other institutions continue to increase their exposure, aware that attractive investment opportunities may exist but that proper due diligence remains key.

When considering hedge fund opportunities for their clients, we believe independent wealth managers must exercise even greater levels of selectivity and diligence than institutions do as their clients are relying on them to serve as alternative investment experts. Many advisors need tools and assistance to help them to deliver on that promise and to navigate the complexities of the hedge fund environment. It is not uncommon for the minimum investment required for a fund to be measured in the millions, and even then access to some of the hedge funds with the longest and best track records is typically restricted to the largest of institutions. It is with respect to these considerations that we believe financial advisors who use the CAIS platform can see the platform’s benefits most clearly. As an open-architecture platform, CAIS has curated what it believes to be premier hedge fund investment opportunities that would ordinarily be inaccessible to independent wealth managers and has made them accessible by harnessing the power of aggregated advisor demand. The collective buying power of the independent wealth channel is a factor in allowing CAIS to offer lower investment minimums for advisors and their clients. CAIS’s partnership with Mercer, a leading independent third-party due diligence provider, provides an objective view of the funds offered to lessen an advisor’s selection burden. In addition, CAIS members benefit from Mercer’s regular market research coupled with invitations to exclusive fund manager and thought leadership events on an ongoing basis. Automated subscription documents and custodial integration combine to make the investment process a more streamlined and straightforward experience from end to end.

In attempting to capture the attention of high net-worth clients from much larger institutions as well as the evolving robo-advisor landscape, we believe independent wealth managers need to differentiate themselves as experts in an array of investment strategies and opportunities in order to be successful. Alternative investments, and hedge funds in particular, can complement that differentiation. Savvy wealth managers should reflect on that potential and seek the knowledge and support that they require to capitalize upon it as appropriate.

This document may not be distributed without the written consent of CAIS. It does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product and is not a complete description of the terms applicable to an investment in any fund or vehicle. Any such offer of solicitation may only be made by means of the fund offering memorandum. This information is based upon information that may be revised without notice to, or the consent of, CAIS, the administrator of the relevant fund, such fund, or any of their respective employees, officers, members, partners or affiliates (or any employee, officer, member or partner of any such affiliate) and should not be relied upon for any purpose whatsoever. The information shown, including any performance information, may be based on estimates provided by third parties (i.e., other than CAIS or any CAIS affiliate). The performance information shown reflects investments made in markets characterized by certain events that may not occur in the future. A fund may calculate metrics similar to those shown in performance information using unrounded numbers and/or monthly returns that are slightly different from those sent to investors in such fund. As a result of the foregoing, it is possible that there may be differences between the data in the information shown and the information provided by a fund and/or its investment manager. While neither CAIS nor its affiliates expect that such differences will be material, no assurance can be given that such differences will not be materially significant. No assurance can be given that any fund referenced herein will be available for investment. The metrics displayed may not provide an accurate portrait of the potential risks involved in investing in any portfolio, fund, any CAIS fund or any group of CAIS funds.